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The Blazing Controversy Over Nu Skin

Is Nu Skin a great value or a super villain?

That's the accusation Buddy the Elf (played by Will Ferrell) leveled at a department store Santa Claus in the movie Elf. And it's essentially what noted short-seller Andrew Left of Citron Research is saying to personal-care products company Nu Skin (NYSE: NUS).

On the other hand, successful investment manager and writer Joel Greenblatt must like the throne Nu Skin sits atop. His fund recently bought nearly 115,000 shares in Nu Skin.

So is Nu Skin the great value Greenblatt thinks it is? Or is it a super villain, as Citron Research paints it? Let's take a look.

Highly valuedThere isn't any controversy about Nu Skin's successful run. Earnings grew more than 32% annually during the last five years. The stock shot up over 170% during the same period. But what most likely attracted Joel Greenblatt is Nu Skin's high return on invested capital, or ROIC, and high earnings yield.

ROIC helps investors determine the quality of a company; the higher, the better. Nu Skin's ROIC currently stands at 26.5%. That level more than doubles the ROIC for the S&P 500. The company's five-year average ROIC of 16.7% is also strong.

Earnings yield, which is calculated by dividing earnings before interest and taxes by enterprise value, helps investors determine how attractively a stock is valued. As with ROIC, higher numbers are better. Nu Skin's current earnings yield is nearly 13%, which indicates an attractive valuation.

When you throw in the company's dividend yield of 1.9% with its appealing valuation and strong growth, it's not hard to see why many investors would like the stock.

Highly vilifiedBut Andrew Left sees a different picture altogether. Left gained notoriety for publicizing alleged problems with companies -- and making money by short-selling the stocks.

His firm, Citron Research, published a report recently alleging that Nu Skin illegally operates a multi-level marketing pyramid scheme in China. Citron also claimed that Nu Skin is in "apparent violation of FDA and/or FTC regulatory law in the U.S." and is "lying about a scientific research relationship with Stanford University for their flagship technology AgeLOC."

The first allegation, if true, represents the most serious potential damage to Nu Skin's growth prospects. The company estimates that 11% of 2012 revenue will come from sales in mainland China, which it sees as a significant source of future growth.

Nu Skin maintains that its Chinese operations are in compliance with regulations. The company cited its eight-year history in doing business in China, stating that the Chinese government regularly reviews its business activities. Nu Skin particularly noted that China has approved multiple new direct-selling licenses within the past year.

Citron's second allegation referenced an FDA import alert about anti-aging creams from March 2012. However, while this particular FDA alert listed dozens of companies subject to surveillance, Nu Skin was not included.

The third allegation prompted Stanford University to ask that Nu Skin remove the name of Dr. Stuart Kim from any marketing materials at Dr. Kim's request. However, Stanford clarified that the university has had a "long-standing research relationship with Nu Skin." As it turned out, Dr. Kim was initially involved in some of that research, but his participation ended.

If we believe Andrew Left, Nu Skin indeed sits on a throne of lies.

Highly vexingWhat should investors do?

Citron Research's track record features several successes. Citron points to American Semiconductor(Nasdaq: AMSC) as one example. The stock traded at more than $40 per share when Citron published a negative report about the company. It now trades around $4.

On the other hand, Garmin(Nasdaq: GRMN) shares hovered around $30 per share when Citron released a gloomy report about the company in late 2009. Garmin now trades near $42.

The jury is still out on recent Citron targets such as Questcor Pharmaceuticals(Nasdaq: QCOR) and VIVUS(Nasdaq: VVUS). Citron attacked both companies with reports in July and caused shares to tank. VIVUS still seems to be reeling, but Questcor shares appear to be climbing back somewhat.

At this point, investors probably should wait and see how the story with Nu Skin unfolds. Left might have spotted a bad apple to avoid or short. Perhaps, though, he has helped create an even greater bargain for long-term value investors. In that case, Santa might have come early this year.

Author

Keith began writing for the Fool in 2012 and focuses primarily on healthcare investing topics. His background includes serving in management and consulting for the healthcare technology, health insurance, medical device, and pharmacy benefits management industries.
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